Indirect causation in securities class actions
In the matter of HIH Insurance Limited (in liquidation) and Others  NSWSC 482
A recent Supreme Court of New South Wales decision will make it easier for investors in listed companies to succeed in securities actions where the allegation is that they paid a higher price for a company’s shares due to the misleading and deceptive conduct of the company: In the matter of HIH Insurance Limited (in liquidation) and Others  NSWSC 482.
Investors will only need to prove that the contravening conduct of the company misled the market and caused shares to be traded at inflated prices (known as indirect market-based causation), rather than the far more onerous task of proving direct reliance, where each investor must show that they directly relied on the contravening conduct when purchasing shares.
The need to prove direct reliance has traditionally made securities class actions less financially viable. This decision is likely to see more securities class actions commenced.
The plaintiffs were investors who acquired shares in HIH between 1998 and 2001.
It was common ground that the published financial results for HIH for 1999 and 2000 were inflated due to the incorrect accounting treatment of certain reinsurance arrangements with Hannover Re. HIH admitted that, in releasing these financial results, it had engaged in conduct that was misleading or deceptive or likely to mislead or deceive, contravening section 52 of the Trade Practices Act 1974 (Cth) (TPA) and sections 995 and 999 of the Corporations Act 2001 (Cth).
The plaintiffs argued that, at the time they purchased their shares, the price at which the shares were trading was inflated due to the misleading financial results.
When HIH went into liquidation, the plaintiffs lodged proofs of debt on the basis that they had suffered loss and damage by reason of having paid more for their shares then they would have otherwise had the market not been inflated. The liquidators did not admit their proofs. The plaintiffs appealed to the Supreme Court of New South Wales.
The plaintiffs did not argue that they relied on the misleading financial results in purchasing their shares; rather they argued that they acquired their shares in a regulated market and the market price was artificially inflated due to those results
Justice Brereton stated that this argument was available to them as the ultimate issue posed by the TPA was one of causation, and not of reliance. The TPA provides that the loss and damage must have been suffered ‘by’ the contravening conduct, which expresses the notion of causation without defining or elucidating it.
His Honour held that the plaintiffs had proved legal causation on the assumption that, had HIH’s conduct not occurred, they would have paid a lesser price for the shares. His Honour also held that factual causation must be established, that is, the conduct must have distorted the market price so as to cause the shares to trade at an inflated price. It was found that the misleading financial results caused the market to assess that HIH was trading more profitably than it actually was and, as a result, its shares traded at an inflated price.
As to measuring the loss, often in misleading and deceptive conduct claims, claimants allege a ‘no transaction’ case, that is, they would not have proceeded with the transaction had the conduct not occurred. This case could not involve a ‘no transaction’ as that requires elements of reliance to be demonstrated.
As such, Justice Brereton rejected the plaintiffs’ position that their loss was the difference in the price they paid for the shares and the value of the shares. Instead, their loss was the difference between the price they paid and a hypothetical price they would have paid had HIH’s conduct not occurred.
His Honour calculated the hypothetical price by applying the price to book value at which the shares traded to an adjusted book value (taking into account the misrepresentation). This allowed HIH’s conduct to be isolated from other market influences.
The claim concerned three financial reporting periods. The plaintiffs were awarded 6.25%, 9.5% and 13% of the price paid for the shares depending on the period in which the shares were purchased.
While this decision will provide encouragement for those wishing to commence securities class actions, claimants in Australia still face significant hurdles in proving market-based losses.
In this case, the defendant admitted to engaging in conduct that was misleading or deceptive. In most class actions, this is likely to be contested.
Additionally, the indirect market-based causation argument is to be distinguished from the ‘fraud on the market‘ theory favoured in the US. That theory creates a rebuttable presumption in favour of claimants that it can be assumed that an investor relied on public misstatements when they buy or sell shares at the price set by the market. Justice Brereton expressly stated that Australian law does not authorise any such rebuttable presumption. Australian claimants still bear the onus of proving that the price of the shares was affected by any contravening conduct, which must be shown as a matter of fact and demonstrated by expert evidence.
Date: 25 October 2016